Editor's note: With all the uncertainty in the markets today, you must have a plan in place...

As Director of Research Austin Root explained yesterday, one way to do this is by choosing to buy stocks of individual companies rather than mutual or exchange-traded funds.

When you know exactly which stocks you're putting your money into, you can learn about the companies behind those stocks... and invest with more confidence as a result.

But no matter how much research you do, it's impossible to account for every risk in an investment. That's where the concept of "margin of safety" comes in... You want to find "bargain" stocks that provide a cushion for when things don't go your way.

In today's Masters Series, adapted from this month's issue of Stansberry Portfolio Solutions, Austin discusses this concept... reveals some of the details about his 2021 investment outlook... and shares how to maintain a margin of safety as valuations continue to soar...

Finding Margin of Safety in an Unsafe Investing World

By Austin Root, Director of Research, Stansberry Research

For each of your investments, what's your margin of safety?

Brilliant investor Seth Klarman explains this idea best in his 1991 opus, Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor.

Klarman may not be a household name, but he should be. Since founding his hedge fund, the Baupost Group, in 1982, he has produced one of the best investment track records of all time.

As Klarman writes...

There are only a few things investors can do to counteract risk: diversify adequately, hedge when appropriate, and invest with a margin of safety.

A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable, and rapidly changing world.

It is precisely because we do not and cannot know all the risks of an investment that we strive to invest at a discount. The bargain element helps to provide a cushion for when things go wrong.

Today, I'll share a few steps that can help you put this cushion in place. But first, let's talk about my 2021 market outlook – and why now is a crucial time to remember the value of having margin of safety in our portfolios...

Despite the volatility, 2020 proved to be a good year for most investors. But I worry that the solid performance across most securities has given us a market with very little margin of safety. And that's something we must be cognizant of as we position our investment portfolios for the year ahead.

As we begin 2021, I'm more worried about a material market correction than I've been since 2008. And yet, I don't see that correction occurring in 2021... Not yet.

This year, I expect the market to keep grinding higher, fueled by a post-vaccine economic burst, ever more and persistent liquidity and stimulus from both the U.S. Federal Reserve and the U.S. Treasury, and a lack of attractive investment alternatives.

The stock market has rallied a lot... It's already up more than 60% from the bottom last March. Retail investor sentiment is high, as the fear of missing out has eclipsed the fear of losing money.

But institutional investors still haven't fully realized that if you compare where we were before the COVID-19 pandemic to where we'll be in just a few short months – when we're (mostly) past the virus – there's really just one major difference...

Governments around the world have provided loads more stimulus and liquidity, including promises that interest rates will stay lower for longer than we ever thought possible.

So with bonds and fiat currencies around the world offering no value (or worse), the bias for nearly all risk assets is even higher prices in 2021.

That's great news. But because stocks, bonds, and preferred stocks are so pricey already based on virtually any historical measure, few assets have any margin of safety today. In other words, it's hard to find investments that provide attractive returns for the risk of loss that they offer.

So how should you play this? Should you stay fully invested in the highest fliers and capture the incredible returns that are possible right near the end? Or is it time to listen to Klarman?

Here's another one of Klarman's gems from Margin of Safety...

The most important metric is not the returns achieved but the returns weighed against the risks incurred. [At Baupost], we have consistently tried not to lose money and, in doing so, have not only protected on the downside but also outperformed.

In other words, these two desires – producing continued strong returns and protecting your assets from losses – are not at odds.

But the level to which you pursue them may vary depending on your investment goals... Are you looking for unfettered capital gains, or do you prefer steady income? Or are you more interested in preserving your wealth than growing it?

You can boost your margin of safety by holding more "dry powder" (cash) and portfolio protection (like short positions or precious metals). And you should reinvest only where you feel far more comfortable about your reward-to-risk ratio.

Another way to position yourself safely is to own only the world's best and most durable businesses – ones that should take more share of their respective industries in a downturn. When you focus on owning these resilient stocks for the very long term, it gives you a huge advantage over most investors.

This process of continuing to maintain a margin of safety even while shares appreciate is something that Klarman also addressed. How does he say to do this?

• By replacing current holdings as better bargains come along.

• By selling when the market price of any investment comes to reflect its underlying value.

• By holding cash, if necessary, until other attractive investments become available.

These are the kinds of strategies you should put in place this year. Despite a chaotic 2020, the market has soared. So have valuations – and they could soar much higher before this bull market ends.

If you give yourself a greater margin of safety now, your portfolio will thank you – and you'll position yourself for a profitable 2021.

Good investing,

Austin Root

Editor's note: Last Tuesday night, Austin joined Dr. Steve Sjuggerud and Dr. David "Doc" Eifrig to share more of his thoughts on what to expect in 2021... and how to come out on top with your investments. Plus, they each revealed a recommendation for the new year... absolutely free to everyone who tuned in. Watch the full replay right here.